As a young man learning about cars for the first time, I remember being confused about the difference between horse power and torque. I won’t attempt  an explanation  now, because I’m sure I’ll still get it subtly wrong and some car guy will correct me, but suffice it to say it’s two related measurements that are highly correlated but not the same thing at all. Cash flow and profit in accounting are the same way. They’re related, and correlated, but not the same thing.

Cash (flow) is king

Let’s start with cash flow, because frankly it’s more important for a small or medium size business’s short term survival (and the stress level of that business’s owners).

Your cash flow, as wikipedia defines it, is “the amount of cash generated and used by a company in a given period.” Another way to define it is – will you run out of bills before you run out of money?

Timing is everything. If you have to make payroll on Friday and your customer will pay you the following Wednesday, you have a problem, even if the customer will pay you far more than payroll costs.

But if you discover this is going to happen two weeks beforehand, you have far more options than if you figure this out 2 days before payday.

You will not discover this problem by looking at accounting income statements, either past or projected.

Profit is hot

Which leads us to the concept of profit – profit is shown when you have more income than expenses for a given period (usually a month or a year). An income statement is simply a presentation of all your income (things like sales, fees invoiced, and so on) and all your expenses (payroll, office equipment and supplies, raw materials, etc.). Add them all up in both categories, subtract expenses from revenues, and you’ve got profit (or loss).

Seems like profit would automatically lead to good cash flow, and over time of course profit is necessary to good cash flow, but the two are NOT the same thing.

What are some factors that can lead to poor cash flow, even if you’re making a little profit?

  • spending based on the current checking balance – I’ve seen many business people make this mistake. They get a large check from a customer, and they go buy the thing they’ve been wanting (either for the business or for themselves) – forgetting they have large obligations coming up in  the near future before another large check is due to arrive.
  • paying fast – it’s good to pay bills promptly. I think it’s immoral to ride creditors and pay slowly if you can possibly help it. But “paying bills as soon as they come in,” which is a point of pride with some owners, can lead to problems, especially if you are
  • collecting slowly – especially in a small business, where the owner is sometimes the person who sold the goods or services, it can be hard to be the collection cop. But “creditors have better memories than debtors,” so it’s up to you to politely remind customers of their obligations.
  • failing to plan and project based on conservative assumptions – we have to start with our current cash (the balances in our checking accounts, PayPal, etc.) and look realistically and even a little pessimistically at our upcoming expenses. If we see negative numbers on some upcoming days, we need to make some adjustments.


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